In my thesis I examined the applicability of traditional valuation methods to value high growth companies. Consequently I presented and discussed possible modifications to the traditional methods, whereas I demonstratively applied some of the presented concepts in the case study. Considering relative valuation, traditional multiples based on historical financial data are not very useful for valuing such companies, as historical earnings are either negative or have low informational value. In my opinion, the presented concept of forward-looking (earnings) multiples is clearly superior to the traditional approaches using historical financials and also to the proposed modifications, which mostly have to be applied using historical data. The concept of knowledge-related multiples is interesting, although it uses historical financials; it may be useful and deliver accurate results in certain cases, but not especially when valuing high growth companies. Multiples based on non-financial data may only work well if a truly comparable company could be found. However, a multiples analysis should generally not be used for standalone company valuations, but rather to complement a DCF valuation, which is regarded as the more accurate method.
In the second part I examined the DCF valuation and found that the general framework works even for high growth firms; only the estimation of separate inputs requires more effort and modified estimation approaches compared to stable growth companies. The scenario-based DCF approach is considered as the appropriate method to account for high uncertainty in company valuation, as it allows examining the effect of changes in fundamental value drivers, without having to use quite intransparent mathematical models. I also presented some in depth estimation issues for three main steps of a DCF valuation, which proved beneficial for doing the case study.
The case study should demonstrate the specific problems relating to the valuation of high growth companies. By trying to value “bwin”, an Austrian online gaming firm, the case study reveals the deficiencies of traditional multiples and shows how the scenario-based DCF approach can be applied. Although scenario outcomes deliver an even broader value range than the multiples analysis, they allow accounting for the specific circumstances and reveal the possible effect of changes in the key value drivers for the company. The scenario-based DCF approach thus delivers the most valuable results in my opinion.
Table of Contents
1 Introduction
2 Relative Valuation
2.1 Traditional Approach
2.1.1 Common Multiples and their Drawbacks
2.1.2 The Accuracy of Multiples and Best Practices
2.2 Modifications and Extensions
2.2.1 Multiples Based on Non-financial Data
2.2.2 Growth-adjusted Multiples
2.2.3 Knowledge-related Multiples
3 DCF Valuation
3.1 General Framework
3.2 Modifications for High Growth Companies
3.2.1 Scenario-based DCF
3.2.2 Estimating Cash Flows
3.2.3 Estimating Growth
3.2.4 Estimating the Discount Rate
4 Other Methods
4.1 Real Options
4.2 Venture Capital Method
5 Case Study: Valuing bwin
5.1 The Problem
5.2 Market Review and Key Value Drivers
5.3 Relative Valuation
5.4 DCF Valuation
6 Conclusion
Research Objectives and Core Topics
The primary objective of this thesis is to critically evaluate the applicability of traditional valuation methods for high growth companies and to explore necessary modifications or extensions that account for the unique characteristics of such firms, specifically regarding their high uncertainty and negative earnings. The research aims to determine whether these adjusted methods provide more reliable valuation results through a practical case study.
- Analysis of traditional relative valuation methods and their inherent drawbacks for high growth entities.
- Evaluation of modifications, including growth-adjusted, non-financial, and knowledge-related valuation multiples.
- Examination of the DCF valuation framework and specific adaptations required for high growth companies.
- Application of scenario-based DCF analysis as a robust approach to model future uncertainty.
- Practical case study of "bwin" to demonstrate the implementation of presented valuation frameworks in the online gaming industry.
Excerpt from the Book
3.2.1 Scenario-based DCF
Koller et al. (2005) and Damodaran (2001) state that traditional valuation principles apply also for high growth companies. Nevertheless modifications of the traditional DCF approach are helpful to cope with the specific characteristics of them. The first method handled is a DCF valuation that starts from the future, in connection with probability-weighted scenarios. In this approach the components of the DCF valuation are the same, the difference lies in their order and their emphasis.
While a traditional DCF valuation for established companies would start with analysing historical performance, in this method the expected long-term development of the market in which the company is active constitutes the starting point of the valuation. As long term projections bear high uncertainty, multiple scenarios should be used. Each scenario should depict a possible development of the market under different conditions, the level of profitability and the investment needed for a firm to be successful. To do this, a point of time in the future has to be determined where the company’s financial performance is likely to stabilize. From this point one has to work backward to link the forecast with the firm’s current performance. Finally probabilistic weights have to be applied to each scenario, which should be consistent with long-term historical evidence about corporate growth.
Summary of Chapters
1 Introduction: Provides an overview of the challenges in valuing high growth companies following the internet bubble and defines the focus on firms in the rapid expansion and high growth lifecycle stages.
2 Relative Valuation: Discusses the traditional approach using multiples, its limitations for high growth firms, and explores various modifications like growth-adjusted and knowledge-related multiples.
3 DCF Valuation: Details the general enterprise DCF framework and explains necessary modifications, such as scenario-based modeling and adjusting for specific high growth input challenges.
4 Other Methods: Reviews alternative techniques including Real Options and the Venture Capital Method, assessing their suitability as complementary tools for company valuation.
5 Case Study: Valuing bwin: Applies the theoretical frameworks to the Austrian online gaming company "bwin" to illustrate the valuation process, including both relative and scenario-based DCF approaches.
6 Conclusion: Summarizes the findings, emphasizing that while traditional multiples have limited use, the scenario-based DCF approach provides the most valuable results for high growth companies.
Keywords
High Growth Companies, Company Valuation, DCF Valuation, Relative Valuation, Multiples, Discounted Cash Flow, Scenario-based DCF, Online Gaming Industry, Market Volatility, Growth Assets, Equity Valuation, Enterprise Value, Risk Premium, Financial Modeling, Intangible Assets
Frequently Asked Questions
What is the core focus of this thesis?
The thesis investigates valuation methods suitable for high growth companies, which often lack a positive financial track record and face high uncertainty, making traditional valuation approaches difficult to apply.
Which central topics are addressed?
The work covers relative valuation (multiples), the discounted cash flow (DCF) framework, real options, the venture capital method, and industry-specific value drivers, particularly in the online gaming sector.
What is the primary research goal?
The goal is to determine how traditional valuation models can be modified or extended to effectively value high growth firms and to test these models through a practical application.
Which scientific methods are employed?
The paper uses a comparative literature review of established valuation theory and an empirical case study approach to apply these theories to the real-world example of bwin.
What does the main body discuss?
The main body critiques historical-data-based multiples, explores forward-looking and knowledge-related extensions, and provides a detailed step-by-step application of a scenario-based DCF model.
Which keywords characterize the work?
Key terms include High Growth Companies, DCF Valuation, Multiples, Enterprise Value, Online Gaming Industry, and Growth Assets.
Why are traditional multiples often ineffective for high growth companies?
They often rely on historical earnings, which are typically negative or volatile for high growth firms, leading to misleading valuation results.
What is the main advantage of the scenario-based DCF method?
It allows for the explicit modeling of various market outcomes and uncertainty, making the underlying assumptions of the valuation more transparent and flexible.
- Quote paper
- Mag. Thomas Prielinger (Author), 2007, Valuation of high growth companies, Munich, GRIN Verlag, https://www.grin.com/document/93094
